Arduino 1.0.2 gives me the option to use parity error detection on serial connections. Does anyone know if I need to manually handle parity errors, or does the Arduino automatically request retransmission?

Would really depend on your sketch, wouldn't it?I am betting manually, not all sending devices would be capable of resending.The protocol you are using would define what happens when parity error is detected.The data may have error correction built in for example, allowing the receiver to correct the error.

I think what you will find is that you will have to study the datasheet for the AVR chip and learn how the various options for parity checking are enabled and how actual received parity errors are detected and signaled. Once you do understand how the underlining hardware functions, then you have to see how you will go about either modifying the existing hardware serial library to integrate this new 'feature' or write your own custom serial library. The fact that the existing hardware serial library utilizes buffered interrupt driven on received characters makes this not so simple a feature to implement.

First you have to ask yourself what you want to happen if and when a character is received that has bad parity detected? Your choices are fairly limited, either just throw the character away or via a protocol you work out with the sender of the characters, send them a signal that you received a bad character and to resend the character or the complete message. So you see it can get quite complex quite quickly and it is very much just a part of the overall serial protocol you wish to utilize between the sender and receiver of serial data.

I do not know about parity errors. When I have tried to transfer data from Arduino to WindowsXP computer with as high speed as possible, it is quite seldom that the received character is wrong. Rather, there are more omissions of one or more characters the higher speed I try (up to about 1 megabaud).

I've decided to chicken out and implement a checksum-based error detection protocol instead of trying to do it with serial parity checking. I suspect that the new Serial.begin() function was implemented so that the Arduino could easily be connected to devices with fixed data & parity settings, (instead of people having to roll their own HardwareSerial library to support a particular device).